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Deleting the Zeros I (6/5/12)

From time to time we read news articles coming out of Iraq mentioning their plans to “delete the zeros” from their currency. Sometimes it’s stated as “remove the zeros”, “lift the zeros”, “drop the zeros”, or “cut the zeros” but they all mean the same thing. They’re talking about a redenomination similar to what has occurred with dozens of other countries over the past century whose currencies have depreciated in value after a period of hyperinflation. Here a few examples:

I could provide more examples with similar references, but you get the idea. All of these redenominations worked essentially the same way. The old currency was replaced by a new currency that was more valuable by multiples of ten, along with a proportionate reduction of the money supply which typically resulted in no net change. A transition period was announced and people were allowed to use the old currency or exchange it for the new before the old was “demonetized” or declared worthless.

In the case of the Iraqi dinar, also a victim of depreciation resulting from a prolonged period of hyperinflation, armchair economists have decided to educate the dinar community that “deleting three zeros” actually means pulling the larger notes with three zeros out of circulation in preparation for a substantial RV. This interpretation is completely baseless. It is unprecedented, it’s not supported by the testimony of people in Iraq reporting the scarcity of larger notes in circulation, and it certainly isn’t supported by the figures from the CBI which show a growing money supply rather than a shrinking supply as one would expect if this were the case.

Recently Ali Agha of Dinar Trade (a man who claims that his family has been in the currency business for generations) has conducted interviews where he discussed the subject of “deleting the zeros”. His interpretation is consistent with the articles I cited earlier. He says that it means a lop, although he’s of the belief that there’s not enough support in parliament to push the plan through, leaving wide open the possibility of the IQD growing in value over a period of time which would be the best scenario for investors.

To reduce the money supply by removing larger notes from circulation in preparation for an RV with no corresponding rate adjustment would result in economic ruin as the people and businesses would be undercapitalized. This scarcity of money would likely result in deflation, which is considered worse than inflation because it causes people to stop spending money. This leads to a slowing economy and a downward economic spiral toward depression.

Since we’ve seen no significant rate adjustments over the past couple of years, and since the GDP is still growing in Iraq, and since the CBI financial reports show a growing money supply I have to conclude that the “removing the larger notes” interpretation is shall we say … caca del toro.

One popular dinar pundit from Texas is fond of saying that removing the zeros means removing the larger notes because they’ve already removed 70% of the zeros and “you can’t remove 70% of an exchange rate”. This is no doubt based on yet another misreading of an article from 2010 stating that Iraq had reduced excess liquidity by 70%, an interpretation which has repeatedly been debunked both here and in several forums. All you need to do is look up the definition of “excess liquidity” in a financial dictionary.

As you can see nothing in this definition refers to the amount of cash in circulation. It’s the excessive amount of cash held by a bank.

The word “delete” means “to eliminate especially by blotting out, cutting out, or erasing“. It doesn’t mean “to remove by gathering or withdrawing from circulation”. It’s referring to the zeros in the exchange rate, not to the larger notes with three zeros. So if I wanted to I could make a similar declaration that “you can’t delete paper money”.

In times of inflation, the same number of monetary units have continually decreasing purchasing power. In other words, prices of products and services must be expressed in higher numbers. If these numbers become excessively large, they can impede daily transactions because of the risk and inconvenience of carrying stacks of bills, or the strain on systems, e.g. automatic teller machines (ATMs), or because human psychology does not handle large numbers well. The authorities may alleviate this problem by redenomination: a new unit replaces the old unit with a fixed number of old units being converted to 1 new unit. If inflation is the reason for redenomination, this ratio is much larger than 1, usually a positive integral power of 10 like 100, 1000 or 1 million, and the procedure can be referred to as “cutting zeroes“.

The definition of “deleting the zeros” is one of the main reasons I concluded that nobody will get rich off of the IQD. It was clear from my research that the term was being misrepresented by dinar gurus and that the CBI was talking about a textbook redenomination which would in all likelihood leave investors with a loss.

When Shabibi was in DC last year he was asked about revaluing the dinar and his response was essentially that it depends on inflation because that’s how they’ve been keeping inflation under control. They’ve been periodically adjusting the exchange rate. Later in that same meeting he was asked about deleting three zeros from their currency. Here he made a clear distinction from a revaluation in that he said deleting the zeros was simply a way to facilitate payments and they had already decided to do this. You can hear his remarks in the video below. (At the beginning of the video he is responding to the question about whether or not they would revalue the dinar.) Shabibi even states that “deleting three zeros” means a redenomination. (3:50) How much clearer could he be?

Maybe Iraq won’t delete the zeros. Maybe parliament will vote down the measure and force the CBI to adopt a policy of slow growth toward a penny as Ali has suggested. If so dinar investors could realize some significant profits even if they don’t get rich from a 1000:1 RV. But whatever happens investors need to be clear on what “deleting the zeros” means. It means lop.